Pre-crisis determinants of US bank charter values.
Fortin, Rich ; Goldberg, Gerson M. ; Roth, Greg 等
INTRODUCTION
During the ongoing global financial crisis, the U.S. banking
industry experienced a sharp increase in the number of bank failures.
Over the seven-year period ending December 31, 2007 there was an average
of only 3.57 bank failures per year. By comparison, over the two years
ending May 31, 2010 there was an average of 119.5 bank failures per
year. (1) In response to this spike in bank failures (and the concurrent
damage to the U.S. economy), many observers have argued that U.S. banks
took excessive risks leading up to the financial crisis. Calls have
increased for tighter government regulation of the banking industry and
on July 15, 2010, the U.S. Congress passed legislation designed to
dramatically overhaul the financial regulatory system. At the same time,
the Basel Committee on Banking Supervision was working to stiffen
international banking regulations. Concerned about excessive bank
risk-taking, this committee was focused on improving the quality and
quantity of bank capital. Not only was the committee considering setting
limits on leverage, how much banks can borrow, it was also considering
setting limits on executive compensation. (2)
To better understand the incentives faced by bank holding company
(BHC) managers in the period shortly preceding the financial crisis, we
analyze factors related to BHC intrinsic value (also known as charter
value) in the year 2006, the year before the crisis began. All things
equal, BHC managers can be expected to favor policies or make decisions
that increase BHC charter value and thus shareholder wealth. Some
actions taken by BHC managers to increase shareholder wealth could also
increase BHC risk. Following prior researchers (such as Furlong and
Kwan, 2005, and Caprio, Laeven and Levine, 2007) we measure BHC charter
value using the market-to-book value of equity. After controlling for
the effects of bank size, recent book ROE, and recent share returns, we
find that BHCs are more highly valued by shareholders when they have
riskier capital structures, superior shareholder rights, and CEO
compensation packages that increase risk-taking incentives. Weaker
evidence indicates that share ownership by insiders on the board of
directors also has a positive influence on charter value, but this
influence is only statistically significant in higher ranges of insider
ownership. Contrary to our expectations, there is no evidence of a
significant relationship between outside share ownership concentration
and charter value. The main conclusions from this study are that, on the
eve of the current financial crisis, shareholders more highly valued
BHCs with better shareholder rights and riskier characteristics.
RELATED LITERATURE
Our research is broadly related to the literature on firm value,
capital structure, ownership structure, corporate governance, and CEO
compensation. However, this paper most directly relates to a narrower
strand of literature concerning influences on bank charter value (or
bank valuation). Several prior studies have analyzed factors that
potentially influence bank charter value, but the evidence is mixed
regarding which variables have influence and no studies (to our
knowledge) have examined influences on charter values in the period
immediately preceding the current financial crisis. The prior evidence
seems to be somewhat dependent on the time period examined, likely
because different studies sample from different points in the business
cycle and from different banking regulatory regimes. Furthermore, the
interpretation of the evidence has evolved over time. For example,
Houston and James (1995) find a positive association between
incentive-based compensation for the CEO and bank charter value. They
interpret this evidence to suggest that compensation policies do not
promote risk-taking in banking. However, more recent evidence (Palia and
Porter, 2004, Chen, Steiner, and Whyte, 2006, and Fortin, Goldberg and
Roth, 2010) suggests that incentive-based CEO compensation (such as from
stock option grants) has a positive influence on bank risk-taking.
Using a sample of BHCs from 21 industrialized countries for the
years 1988-1998, De Nicolo (2001) finds that charter value is negatively
related to BHC size for most of the countries examined. He also finds
that BHC insolvency risk increases with BHC size. De Nicolo concludes
that any size-related diversification benefits or any size-related
economies of scale benefits are dominated by costs associated with
larger banks' increased risk-taking. Furlong and Kwan (2005)
investigate the determinants of US BHC charter value for the years
1986-2003. They note that the operating environment for banks evolved
during these years because of changes in legislation, regulation,
banking consolidation, and technological innovation. For their sample of
large BHCs, Furlong and Kwan find that non-interest revenue, consumer
lending, and operating efficiency had a positive influence on charter
value, whereas commercial lending and real estate lending had a negative
influence on charter value. Regarding BHC liabilities, they find that
transactional deposits and non-transactional deposits had a positive
influence on charter value. Furlong and Kwan provide additional evidence
that the influence of many of these variables substantially changed in
magnitude and statistical significance over time. They offer industry
environment-based explanations for these changes. Caprio, Laeven, and
Levine (2007) analyze the relation between ownership structure and
charter value for the year 2001 using a sample of 244 banks in 44
countries. They find that higher cash-flow rights, held by the
controlling shareholder, increase charter value and help to mitigate the
negative effects of weak shareholder protection laws.
Palia and Porter (2004) analyze the influence of bank capital
structure and managerial compensation on bank charter value for the year
1991, using a sample of 102 BHCs. They find that bank capital (the level
of equity in the bank's capital structure) is strongly, positively
related to charter value. They also find weaker evidence that the dollar
value of stock options held by the CEO is positively related to charter
value. In the conclusion to their article, Palia and Porter specifically
argue that future researchers should gather data from different time
periods and continue to analyze the influences on charter value of both
bank capital structure and bank CEO incentive-based compensation. To
support their argument, Palia and Porter point to Saunders and Wilson
(2001) who find (using data from 1893-1992) that the relation between
bank charter value and bank leverage changes over time and over the
business cycle.
DATA AND METHODOLOGY
In this study, we update the evidence on factors influencing US BHC
charter values by investigating potential charter value determinants in
the year 2006, the year before the current financial crisis began to
unfold. Following Furlong and Kwan (2005) and Caprio, Laeven and Levine,
(2007), we measure BHC charter value as the market-to-book ratio of
equity. In our regressions, the market-to-book ratio measured for the
end of year 2006 is modeled as a function of explanatory variables
measured for the end of year 2005. We are particularly interested in
analyzing whether corporate governance, BHC-level risk characteristics,
and ownership structure variables are related to charter value.
To ensure that our sample of BHCs has available information on
corporate governance, we draw our initial sample from a data base that
is publicly available on Professor Andrew Metrick's web site at
Yale School of Management. (3) Professor Metrick's database
includes a corporate governance index for 1,896 firms (of which 97 are
BHCs) for the year 2005. This index is developed and described in detail
in Gompers, Ishii, and Metrick (2003). Their index utilizes data
collected on 24 separate corporate governance provisions by the Investor
Responsibility Research Center. For every governance provision that
enhances managerial rights (at the expense of shareholder rights),
Gompers, Ishii, and Metrick add 1 to the index value. The final index
value for each BHC relies on count data such that higher values are
associated with worse corporate governance or reduced shareholder
rights. (4)
To observe BHC-level risk characteristics, we gather data on bank
capitalization and managerial incentives to take risk. BHC
capitalization is measured as the book value of equity divided by total
assets. We develop proxy variables for managerial incentives to take
risk by gathering data on CEO incentive-based compensation. The three
variables used are: annual CEO base salary; annual total value of CEO
option grants; and the annual total value of CEO bonuses. Each of these
three variables is scaled by the natural log of total assets. To test
for any influence of ownership structure on charter value, we gather
data on inside director ownership and outside blockholder ownership.
Inside director ownership is the percentage of shares held by all
directors who are full time employees of the BHC. Outside blockholder
ownership is the percentage of shares held by all non-employees of the
BHC who individually own at least 5% of the bank's shares. In each
of the model specifications used we control for BHC size by including
the natural log of total BHC assets. We also control for recent BHC
performance by including the one-year raw stock return and the one-year
book return on equity.
As noted, all explanatory variables are measured for the year 2005,
whereas charter value is measured for the year 2006. All balance sheet
information is drawn from Compustat. All stock return data are drawn
from the Center for Research in Security Prices (CRSP). CEO compensation
data are hand collected from proxy statements. (5) because complete data
are not available for all BHCs in the initial sample, our final sample
includes only 83 large BHCs. Nevertheless, these sampled BHCs held
approximately 61.5% of all FDIC-insured bank assets in the U.S. during
the year 2005 and so represented a large portion of the U.S. banking
industry. (6)
Descriptive statistics for the final sample appear in Table 1. The
mean (median) asset size is $79.8 ($10.2) billion, reflecting the large
size of sampled BHCs. The mean and median market-book ratios are both
close to 2, but the range in charter values is nonetheless considerable.
The minimum market-book ratio is 0.73 while the maximum market-book
ratio is 3.73. The mean and median book return on equity values are both
healthy at over 13%, but market returns for the year were mildly
negative with mean and median values of -3.11% and -2.51%, respectively.
The mean and median values of equity capitalization are both 9%, but
capitalization ranges from a low of 3% to a high of 16%. The mean
(median) CEO salary is $679,400 ($643,100); however, the typical CEO
received a substantial portion of total compensation in the form of
option grants and bonuses. The mean (median) value of CEO option grants
for the year is $1,457,800 ($340,600). The mean (median) value of CEO
bonuses for the year is $1,086,100 ($480,000). Additionally, there is
significant variation across BHCs in the use of incentive-based CEO
compensation. Sampled BHCs show a wide range in the level of shareholder
rights. Although the mean value and median value for the corporate
governance index are both around 9, the minimum value is 3 whereas the
maximum value is 15. The mean (median) outside block ownership is 12.4%
(11%), which is substantially more than the mean (median) value of
inside director share ownership at only 5.46% (2.55%).
RESULTS
Regression results appear in Table 2. In all models the dependent
variable is the BHC market-book ratio (the proxy variable for charter
value) measured in the year 2006. All explanatory variables are measured
in the year 2005. Breusch-Pagan (Cook-Weisberg) tests indicate that
heteroskedasticity is present in the data, so we report results using
White's (1980) corrected standard errors. Model 1 includes the
three control variables STOCKRET, ROE, and SIZE. Model 1 also includes
the variable CAPITAL. Each of the variables in Model 1 is significantly
related to charter value at the 5% level or better. As expected, BHC
market performance and operating performance for the prior year,
measured as the unadjusted stock return (STOCKRET) and the book return
on equity (ROE), are both positively related to charter value.
Consistent with the results presented in De Nicolo (2001) using
international data, we find that BHC charter value is negatively related
to the total value of BHC assets (SIZE). De Nicolo observes that larger
BHCs are often viewed as having greater diversification benefits. Larger
BHCs may also benefit from a perceived implicit government guarantee
associated with being "too-big-too-fail." On the other hand,
smaller BHCs generally are faster growing. In the pre-crisis year 2006
(when the probability of BHC failure was likely perceived as low), this
faster growth effect seems to dominate so that smaller BHCs are awarded
higher valuations.
In contrast to the results obtained by Palia and Porter (2004), we
find in our sample that the level of equity in BHC capital structure
(CAPITAL) is strongly, negatively related to charter value. This
negative relation is significant at better than the 1% level in Model 1
as well as in all models subsequently used in Table 2. Our conclusion is
that, after controlling for a variety of other factors, BHCs with
riskier capital structures were valued more highly by shareholders in
2006. The two most likely explanations for this finding are: (1)
increasing competition faced by BHCs; and (2) declining perceived
default risk. Regarding explanation (1), it has long been recognized
that government supported FDIC deposit insurance creates an incentive
for bank managers to increase risk by decreasing equity capital levels
(see, e.g., Merton, 1977). Keeley (1990) argues that this moral hazard
problem is exacerbated by increased competition within the banking
industry and by increased competition banks face from non-bank financial
institutions. Specifically, Keeley argues that when a bank suffers a
loss of market power because of increased competition, the bank's
shareholders have less to lose if the bank fails, forfeiting its
charter. So, when banks face increasing competition, shareholders prefer
bank managers to take more risk. In 2006, banks faced unprecedented
competition from non-bank financial institutions (which included members
of the so-called "shadow banking system"). (7) Regarding
explanation (2), shareholders may have preferred banks that used
financial leverage to increase returns in 2006 because the probability
of bank failure appeared exceptionally low. According to the FDIC's
web site, there was not a single bank failure in all of 2005 or 2006.
(8) In comparing the results from this study with the results from Palia
and Porter (2004), recall that their sample year is 1991 and that the US
savings & loan crisis occurred from 1989-1991. Because so many
financial institutions had just failed prior to Palia and Porter's
sample period, that period arguably captures a time of decreased
competition faced by surviving BHCs and increased perceived default
risk. We conclude this is the most reasonable explanation for their
finding of a positive relation between capital and charter value whereas
we find a negative relation between these variables.
In Model 2 the corporate governance index (GOVERN) is added as an
explanatory variable. This index is negatively related to charter value
at the 0.084 level. Because shareholder rights decrease as the value of
the index rises, the results from Model 2 suggest that BHCs with
superior shareholder rights are valued more highly by shareholders. In
Models 3-5, the variable GOVERN retains its negative relation at the 10%
level or better. In Model 3, the three CEO compensation measures are
added as explanatory variables. The variables SALARY, OPTIONS, and BONUS
measure the scaled dollar values of the CEO's base salary, option
grants, and bonuses, respectively. SALARY is not significantly related
to charter value (p = 0.152). However, OPTIONS is positively related (p
= 0.011) and BONUS is positively related (p = 0.057) to charter value.
These results suggest that shareholders value BHCs more highly when
their CEOs have incentive-based compensation that encourages
risk-taking. (9)
In Model 4, the ownership structure variables are added to the
model specification. INSIDE measures the percentage of shares held by
board members who are also full-time employees of the BHC. OUTSIDE
measures the percentage of shares held by all outside investors who
individually own at least 5% of BHC shares. Neither of these variables
is found to be significantly related to charter value. However, evidence
from Stulz (1988), Morck, Shleifer, and Vishny (1988), and McConnell and
Servaes (1990) suggests that a nonlinear relationship exists between
managerial ownership and firm value. In Model 5, we investigate this
possibility by replacing INSIDE with the following three variables:
LOWINS; MEDINS; and HIGHINS. These variables divide the full range of
inside director ownership into three parts: 0 to less than 2%; 2% to 4%;
and above 4%, respectively. (10) The results show that increases in
insider ownership through low and middle ranges have no relation to
charter value. However, HIGHINS is positively related to charter value
(p = 0.092), providing some support for the view that the relation
between managerial ownership and BHC value is nonlinear. (11)
SUMMARY AND CONCLUSIONS
This study analyzes factors related to bank holding company (BHC)
charter value (measured as the market-book ratio) in the year 2006, just
before the 2007-2010 financial crisis began to unfold. The main findings
are that shareholders place higher values on BHCs that are more
shareholder-friendly and that adopt riskier characteristics. Charter
values are higher for BHCs that have stronger shareholder rights.
Charter values are also higher for BHCs that pay CEOs more in options
and bonuses, i.e., incentive-based forms of compensation that likely
promote risk-taking. Perhaps most concerning to regulators, charter
values are lower for BHCs that have greater equity financing.
Our finding that shareholders prefer BHCs with greater financial
leverage directly contrasts the results found by Palia and Porter (2004)
who analyze BHC charter value using 1991 data. They find that greater
use of equity financing has a positive influence on BHC charter value.
The two most likely explanations for these contrasting findings relate
to: (1) the competitive environment faced by BHCs at the time; and (2)
the perceived probability of BHC failure at the time. Palia and Porter
(2004) draw their sample at the end of the 1989-1991 savings & loan
crisis, a time when many financial institutions had just failed. During
this period, surviving BHCs faced reduced competition, but the perceived
probability of bank failure was high. These conditions would likely
cause shareholders to prefer BHCs with less financial leverage. In
contrast, we draw our sample just prior to the 2007-2010 financial
crisis. During this period, BHCs faced increased competition, but the
perceived probability of bank failure was low. These conditions would
likely cause shareholders to prefer BHCs with greater financial
leverage.
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END NOTES
(1.) The source for these data is the Federal Deposit Insurance
Corporation's web site:
http://www.fdic.gov/bank/individual/failed/banklist.html.
(2.) In response to the financial crisis and the belief that
executive compensation encouraged bank risk taking, policy makers in
Europe and the U.S. have already taken steps to limit such compensation.
For example, on June 30, 2010 the European Parliament approved placing
certain limits on cash bonuses for bank CEOs. On June 10, 2009, the
Obama Administration announced that Kenneth Feinberg would oversee
executive compensation for financial firms that received substantial
Troubled Asset Relief Program (TARP) assistance.
(3.) These data can be found at http://www.som.yale.edu/
faculty/am859/data.html.
(4.) These corporate governance index data have been used in
several prior studies, e.g., Gompers, Ishii, and Metrick (2003), Klock,
Mansi, and Maxwell (2005), Core, Guay, and Rusticus (2006), Dittmar and
Mahrt-Smith (2007) and Hwang and Kim (2009).
(5.) To calculate the dollar value of CEO stock options in 2005, we
use the maturity matching Treasury Constant Maturity Rate (the
"risk free rate") at the end of 2005. Annualized dividend
yields are calculated using Compustat data. Compustat is also used to
obtain stock prices for the end of year 2005. We use the Black-Scholes
(1973) option pricing formula as modified by Merton (1973).
(6.) The sample of BHCs and some of the BHC-level data used in this
study were also used in a prior study by Fortin, Goldberg, and Roth
(2010), who examine influences on BHC risk-taking.
(7.) Non-bank financial institutions include mortgage companies
(such as Countrywide Financial Corp.), savings & loans, investment
banks, money market funds, hedge funds, consumer finance companies and
others.
(8.) Perceived default risk was low throughout the economy, as
evidenced by the declining spread between Baa rated corporate bond
yields and 10-year Treasury bond yields. On the last trading day of the
year 2002, the spread was 348 basis points. By the last trading day of
2006, the spread was only 164 basis points.
(9.) As noted, Palia and Porter (2004), Chen, Steiner, and Whyte
(2006), and Fortin, Goldberg, and Roth (2010) find a positive
relationship between bank CEO option payments and bank CEO risk taking.
Coles, Daniel, and Naveen (2006) find a positive relationship between
CEO option payments and firm risk taking for nonfinancial firms.
(10.) Model 5 is a piecewise linear regression that follows the
technique described in Morck, Shleifer and Vishny (1988), except that we
use different percentage ownership cutoff points. Our three ranges of
insider ownership are chosen because they divide our full sample into 3
approximately equally sized subsamples.
(11.) As a robustness check, we also tested our sample for
potentially influential observations using regression diagnostics
discussed in Belsley, Kuh, and Welsch (1980). We then re-estimated Model
4 and Model 5 after removing six BHCs identified as potentially
influential. Our overall results are qualitatively similar using this
reduced sample size, though p values drift slightly higher for some
variables. We conclude that the results shown in Table 2 are not driven
by outliers.
Rich Fortin, New Mexico State University
Gerson M. Goldberg, University of Connecticut
Greg Roth, New Mexico State University
Table 1
Summary Statistics for Sampled Bank Holding Companies
Variable N Mean Median
Assets (in $ billion) 83 79.8086 10.1613
Charter 83 2.0947 2.0230
ROE 83 0.1396 0.134550
Market Return 83 -0.0311 -0.0251
Capital 83 0.0904 0.0890
Govern 83 9.4458 9.0000
Inside Ownership (in %) 83 5.4640 2.5500
Outside Ownership (in %) 83 12.4004 11.0000
CEO Salary (in $ million) 83 0.6794 0.6431
CEO Options (in $ million) 83 1.4578 0.3406
CEO Bonus (in $ million) 83 1.0861 0.4800
Variable Std. Dev. Min Max
Assets (in $ billion) 252.6373 1.7758 1494.037
Charter 0.6143 0.7300 3.7270
ROE 0.0456 -0.0349 0.2655
Market Return 0.1389 -0.7759 0.2031
Capital 0.0197 0.0330 0.1590
Govern 2.8209 3.0000 15.0000
Inside Ownership (in %) 9.1833 0.0200 66.9000
Outside Ownership (in %) 10.5009 0.0000 53.4700
CEO Salary (in $ million) 0.2674 0.0000 1.5000
CEO Options (in $ million) 3.0508 0.0000 20.5680
CEO Bonus (in $ million) 1.9107 0.0000 12.0000
Shown are descriptive statistics for the sample of bank holding
companies. Each bank was drawn from the corporate governance index
database, which covers financial and nonfinancial firms, that is
publicly available on Professor Andrew Metrick's (Yale University)
Web site. All variables except Charter use data from the year 2005.
Assets is the total value of bank assets. Charter is the
market-book ratio (a proxy variable for bank charter value) for the
year 2006. ROE is the book return on equity. Market Return is the
unadjusted one-year stock return. Capital is the equity-assets
ratio. Govern is the corporate governance index. Inside Ownership
is the percentage of common shares owned by inside directors
(directors who are full-time employees of the bank). Outside
Ownership is the percentage of common shares owned by outside
blockholders (non-employees of the bank who own at least 5% of the
bank's outstanding shares). CEO Salary is the base salary paid to
the CEO. CEO Options is the total value of options granted to the
CEO, estimated according to the Black-Scholes (1973) model as
modified by Merton (1973) to account for dividends. CEO Bonus is
the total value of bonuses paid to the CEO. Summary statistics for
dollar values of bank assets and CEO compensation components are
reported in this table, however the natural log of assets and
scaled values of CEO compensation components are used in
regressions.
Table 2
Bank Risk Regressions
Variable Model 1 Model 2 Model 3 Model 4 Model 5
Intercept 2.3513 2.5157 3.4674 3.5238 3.8516
(0.000) (0.000) (0.000) (0.000) (0.000)
STOCKRET 0.0116 0.0121 0.0118 0.0116 0.0121
(0.028) (0.024) (0.016) (0.022) (0.017)
ROE 0.0840 0.0839 0.0821 0.0819 0.0807
(0.000) (0.000) (0.000) (0.000) (0.000)
SIZE -0.0721 -0.0737 -0.1993 -0.2035 -0.2182
(0.009) (0.008) (0.001) (0.002) (0.001)
CAPITAL -7.6827 -7.0884 -8.0194 -8.2379 -8.4374
(0.003) (0.005) (0.002) (0.001) (0.001)
GOVERN -0.0211 -0.0239 -0.0228 -0.0247
(0.084) (0.053) (0.069) (0.055)
SALARY 0.0000 0.0000 0.0000
(0.152) (0.171) (0.182)
OPTION 0.0000 0.0000 0.0000
(0.011) (0.011) (0.008)
BONUS 0.0000 0.0000 0.0000
(0.057) (0.062) (0.044)
INSIDE 0.0021
(0.438)
OUTSIDE -0.0021 -0.0021
(0.573) (0.578)
LOWINS -0.0679
(0.441)
MEDINS -0.0144
(0.797)
HIGHINS 0.0040
(0.092)
(Adj.) [R.sup.2] 0.6045 0.6134 0.6632 0.6654 0.6699
N 83 83 83 83 83
Shown are the results of regressing bank risk on several variables.
The sample includes 83 large bank holding companies. All variables
except Charter use data from the year 2005. The dependent variable
is Charter, the market-book ratio for the year 2006. STOCKRET is
the unadjusted one-year stock return. ROE is the book return on
equity. SIZE is the natural logarithm of total assets. CAPITAL is
the equity-assets ratio. GOVERN is the corporate governance index.
SALARY is the base salary paid to the CEO scaled by the natural log
of total assets. OPTION is the total value of options granted to
the CEO scaled by the natural log of total assets. BONUS is the
total value of bonuses paid to the CEO scaled by the natural log of
total assets. INSIDE is the percentage of common shares owned by
inside directors (directors who are full-time employees of the
bank). OUTSIDE is the percentage of common shares owned by outside
blockholders (non-employees of the bank who own at least 5% of the
bank's outstanding shares). LOWINS, MEDINS, and HIGHINS are three
ranges of inside director ownership. Coefficient estimates are
shown on the top row for each variable. P-values are shown in
parentheses. In all Models heteroskedasticity is present so White's
(1980)-corrected standard errors are used.
